Breakout trading is used by active investors to take a position within a trend’s early stages. Generally speaking, this strategy can be the starting point for major price moves, expansions in volatility and, when managed properly, can offer limited downside risk. Throughout this article, we’ll walk you through the anatomy of this trade from start to finish and offer a few ideas to better manage this trading style.
What Is a Breakout?
A breakout is a stock price that moves outside a defined support or resistance level with increased volume. A breakout trader enters a long position after the stock price breaks above resistance or enters a short position after the stock breaks below support. Once the stock trades beyond the price barrier, volatility tends to increase and prices usually trend in the breakout’s direction. The reason breakouts are such an important trading strategy is because these setups are the starting point for future volatility increases and large price swings. In many circumstances, breakouts are the starting point for major price trends.
Breakouts occur in all types of market environments. Typically, the most explosive price movements are a result of channel breakouts and price pattern breakouts such as triangles, flags or head and shoulders patterns . As volatility contracts during these time frames, it will typically expand after prices move beyond the identified ranges.
Regardless of the time frame, breakout trading is a great strategy. Whether you use intraday, daily or weekly charts, the concepts are universal. You can apply this strategy to day trading, swing trading or any style of trading.
With breakout trades, the goal is to enter the market right when the price makes a breakout and then continue to ride the trade until volatility dies down.
With stock or future trades, volume is essential for making good breakout trades so not having this data available in the forex leaves us at a disadvantage. Because of this disadvantage, we have to rely not only on good risk management, but also on certain criteria in order to position ourselves for a good potential breakout. If there is large price movement within a short amount of time then volatility would be considered high.
On the other hand, if there is relatively little movement in a short period of time then volatility would be considered low. While it’s tempting to get in the market when it is moving faster than a speeding bullet, you will often find yourself more stressed and anxious; making bad decisions as your money goes in and then goes right back out. This high volatility is what attracts a lot of traders, but it’s this same volatility that kills a lot of them as well.
The goal here is to use volatility to your advantage. Rather than following the herd and trying to jump in when the market is super volatile, it would be better to look currency pairs with volatility that is very low.
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